Monday, June 13, 2016

GDP Puzzle II: 2015-16


   With the latest GDP estimates surprising the market, analysts have suddenly noticed that there is such a thing as discrepancy. Based on this, a wide range of completely desperate conclusions are being drawn about GDP growth. Estimates of 5% to 8% are being bandied around. The hoary issue of new versus old system of GDP measurement has again been dis-interred. This note tries to clarify the new issues raised.[i]

GDP Measurement

  GDP is estimated from supply side by aggregating the vale added in different sectors such as Agriculture manufacturing(nanf), electrcity (elec) and construction(const) and from Demand Side by aggregating private consumption(C), government consumption (G), total investment (I)and exports (X)  minus imports(M). The difference between the two estimates is shown as a discrepancy(Disc). Mathematically these can be represented as,
Supply side estimate of GDP = GVA + Tax -Subs
           = GVA (Agri + Manf + elec + Const+...) + (Tax - Subs) 
         where Tax = Producer Taxes and Subs = Producer Subsidy.
Demand Side estimate of GDP= C+G + I +(X-M)
Discrepancy = GDP (demand side) - GDP (supply side)
    The data basis for supply side estimation is historically better, in India, than for demand side estimates, so the discrepancy is shown in the demand side estimates.  Over the past four years 2012-13 to 2015-16 the average growth of GDP ( in constant 2011-12 prices) as measured by the supply side has been 6.8% per annum, 0.5% point faster than GDP growth  of 6.3%  measured by the demand side.  In contrast the average growth in nominal terms is an identical 11.7% from both supply and demand sides.  Thus the difference in real growth rates is entirely due to the 0.5% difference in the price deflators: The supply side price deflator (inflation) has averaged 4.6%, while the demand side deflator has averaged a higher 5.1%.  As the difference in inflation is the largest in 2015-16 (3.7% - 1.1% = 2.6%) the real growth differential is also the highest in 2015-16 (5.2% - 7.6% = - 2.4% ). 
   In 2015-16 real GDP as measured from demand side has grown by 2.4% points slower than the real GDP as measured from supply side, because inflation (deflator) as estimated from the demand side is 2.6% points higher than the inflation (deflator) as measured from supply side.  Thus a majority of the producer sectors of the Indian economy were characterized by deflation ranging from -1.1% to -2.6%.  In contrast consumption demand (private & public) was characterized by positive inflation ranging from 3.1% to 4.5%, with only investment and external trade (Import & export) showing deflation.
For those inclined to blame everything on the change from old method to new method, the following comparison is useful: The discrepancies in current prices in the new accounts for 2011-12, were only 0.72, of the errors and omissions in the old accounts. The numbers for 2012-3 and 2013-4 (0.08 and 0.04 respectively) possibly because the revisions to the old accounts became redundant with the arrival of new ones.
    The UN-IMF system of GDP accounting was devised during a period of positive inflation, when few thought 90% of World could face deflation in several parts of the economy and for periods ranging to  year or more. In normal times various indicators of inflation diverge temporarily and converge either on annual basis or even on a moving average basis. This was the case in India for the Wholesale price index and the different indicators of CPI. Since the Global financial, the latter along with the new CPI index, have diverged progressively from the WPI (even adjusted for different weights) and shows no signs of converging. These divergences have translated into divergences in the deflators for different sectors and demand components. This methodological problem is probably most acute in transition from inflation to deflation and the reverse. I would hypothesize that the inflation-deflation dynamics is likely one reason for the increasing gaps.

Quarterly Data

  When we move from Annual GDP to Quarterly GDP the data basis is even weaker as much data is available (minimum acceptable quality) only on annual basis. Quarterly data is useful for judging trends in different components on the supply side and the demand side, though the latter are even poorer than in the annual data.  The quarterly trends for GDP & components are most useful when FY Q2 & Q3 data becomes available, least for Q4 (as full FY available). This is partly because the UN-IMF NAS/ GDP methodology that we follow, has technical rules for certain estimates in quarterly acts which r confusing even to users.   These are pragmatic rules of thumb based on historical experience.
  Analysts have made too much of a deal of GDP growth in the fourth quarter: Both the 7.9% growth shown by the supply side and the 5.4% growth shown by the demand side.  More significantly the  quarterly data show that during the second year of drought, private consumption maintains it slow but steady recovery, while gross fixed investment remains on a downtrend with large quarterly fluctuations.


     The annual data for 2015-16 confirms the estimate of 7.6% GDP growth that the CSO had estimated in February 2016.  This strengthens the confidence I have in the forecast I made at end-march 2016, before the forecasts of the monsoon appeared (based on the history of consecutive droughts). [ii] To summarixe:
(1)    That GDP growth in 2016-17 will accelerate to between 7.8% and 8.1%.
(2)     Growth  will be much more evenly distributed than in the past two years, with both the agricultural sector and the large corporate sector accelerating more than the rest of the economy.


A version of this article appeared on the Op Ed page of the Indian Express dated 13th June, 2016 under the banner, "Gross Domestic Perplexity".  .

[i]  For the old one see

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